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Backdoor Roth: Planned vs Unplanned

posted on March 8, 2016

How to do the backdoor Roth and how to report it on the tax return are popular topics on this blog. Many people are doing the backdoor Roth pre-planned. They know their income is too high for contributing directly to their Roth IRA. So they do it indirectly through the backdoor. By following the complete how-to, they are able to make it tax-free and really easy to report on their tax return.

Unplanned Backdoor Roth

Many others find themselves doing it unplanned. They contributed to their Roth IRA but only later they found out their income was too high. They found out only when they were doing their taxes the next year. The tax software or their tax preparer told them they weren’t eligible to contribute to their Roth IRA.

Then they learned that they could recharacterize it to traditional — or if they haven’t yet contributed, just contribute to traditional for the previous year — and then convert it. So they did. This made it an unplanned backdoor Roth.

As with many things in life, it’s much better to be proactive and do it planned as opposed to being reactive and doing it unplanned. There are some pitfalls in doing the backdoor Roth unplanned.

Pro Rata Rule

First there is that pro-rata rule. If you have other traditional, SEP, or SIMPLE IRAs, sometimes coming from a rollover from a previous 401k or 403b, the unplanned backdoor Roth will make you pay taxes at today’s high tax rate as if you converted some pre-tax money unless you “hide” those pre-tax IRAs.

The customer service rep at your IRA provider doesn’t know whether you have other IRAs. You could contribute or recharacterize to traditional and then convert, but it doesn’t necessarily mean you will owe zero taxes from doing so. That’s a big reason for not taking tax advice from customer service reps.

Tax Return Confusion

Then there is confusion from contributing *for* one year and converting *in* a different year.

When you are proactive, you can contribute for the current year and convert in the same year. It will make it clean and easy to report on your tax return.

When you are reactive, by the time you realize your income is too high, chances are it’s already after December 31. You end up converting in the following year. Even when the conversion is tax free because you don’t have other IRAs, you still have to deal with splitting the tax reporting in two different years. Almost all the questions and confusion on how to report backdoor Roth come from this camp.

What should you do if you did an unplanned backdoor Roth?

Hide Pre-Tax IRAs

It would’ve been better to “hide” your other IRAs before you converted, but since you already converted, now it’s time to catch up on moving those pre-tax IRAs out of the way. If you leave the pre-tax IRAs alone to the end of the year in which you converted, you will trigger the pro-rata rule. So don’t wait.

Split Tax Reporting

When you contribute *for* one year and convert *in* a different year, you will have to split the tax reporting to two different years. In the first year you report the contribution. In the second year you report the basis carried over from the first year and your conversion. You will have to remember. The confusion is your penalty for doing it unplanned.

Catch Up

You were already caught by an unplanned backdoor Roth in one year. Don’t let it happen every year. If there is any chance that your income may be too high again, resolve that you will become proactive and do a planned backdoor Roth from this year forward. When in doubt, do the planned backdoor. Don’t wait after the year-end.

After you contribute or recharacterize to traditional for the prior year, also contribute to traditional for the current year. Convert twice or simply convert both together. This way you break out of the cycle of doing it after the fact. It will be smooth next year.

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My wife and I made contributions to Roth IRA (2x$5,500=$11,000) in 2014 for the year of 2014, and we made another 2x$5,500=$11,000 Roth IRA contribution at the beginning of 2015 for the year of 2015. But then, right before we filed our 2014 tax return, we found that our AGI for 2014 was high, so we re-characterized all these Roth contributions (about $22,000) to Traditional IRA, and then converted them to Roth IRA.

All these happened in 2015, and my question is: Do I need to amend my 2014 tax return? Thanks a lot.

If you didn’t file 8606 forms with your 2014 tax return, find the old form on IRS website and file them by themselves now. One copy for each person, just fill out the first few lines, which then flows to line 14.

For 2014, I did file two 8606 forms (one for me and one for my wife) and reported a traditional IRA contribution of $5,500 for each person, though the re-characterization happened in 2015 (before April 15). So we do not need to amend our 2014 return?

Problem is, this year we received all 1099-R forms related to these transactions, including the re-characterization of our 2014 Roth contributions. Shouldn’t we report all of them?

2014 is fine. Move on to 2015. If you use software, it will prompt you to include a statement explaining what you did. If you are doing it by hand, read the instructions for what you need to include in your statement.

Hello Harry,
My wife and I contributed the max to our ROTH accounts in 2015. An unforeseen circumstance in 2015 pushed our combined AGI over the limit for ROTH contributions. We realized this during tax prep in 2016.

My finance person sent a bunch of paperwork in March 2016, and in short we did the following transactions:

1 – recharacterized the ROTH to Traditional IRAs

then

2 – converted the Traditional back to ROTH using the backdoor

My financial institution says that we will receive our 1099-R’s in late 2016. Do we report anything on the 2015 taxes in Turbotax, or do we wait for the 1099-R’s and report the moves made for 2014/2015 on the 2016 taxes?
Thank You!
Noel

Harry, great article, as usual. I did exactly that for 2016 and I am all set come April of 2017 (contributed to IRA and converted to Roth IRA in Jan-Feb 2016).

I just filed my tax return for 2015. Unfortunately, my Custodian (ML) sent me my 2015 1099-R with $11,000 – I contributed $5,500 for 2014 in February of 2015 and then converted in May (after the deadline). I contributed another $5,500 for 2015 in May of 2015 and converted in December of 2015.

Assuming I did everything right for prior years – what are my consequences for reporting only $5,500 for 2015 as a basis? I don’t think it’s an audit issue, but rather a mismatch b/n my return and what ML sends to IRS? ML did put a distribution code “2” in box 7.

What do you mean by “reporting only $5,500 for 2015 as a basis”? You are carrying forward $5,500 basis from 2014. When you add the $5,500 you contributed for 2015 to that, your $11,000 distribution on the 1099-R is fully covered. After the conversion, your basis for 2015 becomes zero.

While recharacterization is perfect for traditional IRA accounts, is there any recourse for a 401k to a 401k roth recharacterization? My taxes for 2015 are now too high and I need some means for reducing last years income. Any help is greatly appreciated. Thank you.

I found your articles are very useful. But my situation is a little different.

I have two non-deductible contributions T-IRA account (two different brokerage).
The first T-IRA account was opened in 1996, I contributed $2000 in 1996, and $2000 in 1997. Now the account has values up to $25,000 (gained).
The other T-IRA account was opened in 2012. The total contribution from year 2012 to 2015 are $24,000, the account has values up to $22,000 (lost)
My question is:
1) I want to use backdoor ROTH IRA. Can I convert 2015 T-IRA to ROTH IRA? If yes, how to?
2) If I want to use backdoor Roth IRA for 2016, can I just follow your steps ? Can I skip to step 2 or I have to “hide” my TWO non-deductible T-IRA ?
3) Can I only convert my 2nd T-IRA(lost) to Roth IRA and leave the first T-IRA unchanged to avoid tax on the big earning?

All your traditional, SEP, and SIMPLE IRAs are treated as one giant IRA. If all the contributions you mentioned were non-deductible, you contributed $28,000 and the total value is now $47,000. If you want to pay minimal taxes when you convert to Roth, you will have to “hide” $19,000 worth of money not-yet-taxed. It’s OK to contribute before you “hide” but it’s better to “hide” before you convert.

From your article, the first step “hide” is for pre-tax contribution. Since my contribution are all non-deductible, how to “hide” these $19,000 money not-yet-taxed? Do I need rollback or convert to other account?

Two years ago I contributed into Roth IRAs for me and my wife, but later I found that my income was over the limit. So I did go through all the steps you just described in “unplanned backdoor roth.”

Last year I wait until the end of the year to see if I need to do a regular or backdoor Roth IRAs. since my income criss-crosses around the limit. Again my income was over the limit so I did the planned backdoor Roth IRAs for me and my wife.

This year I’m not sure if my income will be over the limit since I got the pay cut due to industry downturn. Instead of waiting until the end of the year to confirm, should I go ahead and do the planned backdoor Roth IRAs now? I don’t see any downsize to do backdoor Roth even if income is well under the limit, except more involvement and time.

Harry, Great articles, unfortunately I am a bit of a novice and I have a couple of questions to make sure I’m getting this correct.

I have had a Roth for about 8 years, in 2014 I over-contributed to my Roth based on my AGI but was still able to partially contribute. In March, 2015 $515.86 was converted to a traditional IRA then $517.48 was recharacterized back into my Roth, I received a 1099-R for both transactions… do they both get reported on my 2015 return? Also, the traditional IRA had a balance of $0 before and after this process… therefore is my basis $515.86?

You got ‘convert’ and ‘recharacterize’ backwards. The $515.86 recharacterized should’ve been reported on 2014 return as a non-deductible contribution, which becomes a basis carried over to 2015. You still enter the 1099-R into TurboTax. It will see the code and tell you what to do.

So if I recharacterized $515.86 into a traditional IRA from my roth (and that was all the money that was in the traditional IRA (had a prior balance of 0) and this occurred in 2015, and then a day later I converted $517.48 back into the Roth, is my basis 0 or is it $515.86? Is the $515.86 considered a non-deductible contribution since it was after-tax money that went into my Roth in 2014?

Your basis is the amount you originally contributed to your Roth IRA in 2014 before you recharacterized in 2015. If $100 turned into $515.86 by the time you recharacterized, your basis is $100. If $500 turned into $515.86, your basis is $500.

I am thinking of a back door Roth Conversion and have a quick question. I plan to move my traditional IRA (funded by deductible contributions) into my 401K (the plan accepts this). avoid the IRA aggregation rule. How long does the “rolled over traditional IRA” need to stay in the 401K to avoid the IRA aggregation rule?

Hello, hope you can advise. This year going through my taxes I noticed that I over contributed $5500 to my Roth IRA in tax year 2014. Basically I contributed and got married in 2014, but my wife an I filed as married but filing separate, and I did not know that I’m allow to contribute to a Roth IRA if I file married and file separate and have income over 10K. In 2015 I contributed another $5500, again unaware during the year, however now that I noticed it I called my IRA custodian, and asked them to do the backdoor roth for the 2015 contribution, and return my 2014 contribution as the time for anything has expired. What do I have to do with my taxes? Do I have to amend my 2014 taxes stating that I over contributed? Do I need to amend or just file a 2014 5329 by itself? Also what do I do for my 2015 taxes, do I file them without any penalties and then amend it after fixing the 2014 return. Really confused how to fix all this.
Or is it easier, If I don’t do anything, since I have removed all excess contributions should I just wait for a tax bill and the 6% penalty? Thanks,

Harry Sit – First, thanks for your education and time on this forum, it’s been a Godsend.

I would think our situation would be the most common but I could not find it in reviewing all your posts. My wife and I didn’t contribute during the actual tax year due to late December distributions that might put us over the income limit for Roth contributions (which they did). If you have covered this already, please point me in the right direction.

In March 2015 my wife and I both contributed a non-deductible $6,500 for tax year 2014 to our empty traditional IRAs and then did a “distribution conversion” to our Roth IRAs. The only reporting on our 2014 tax return was on Form 8606 lines 1, 3 and 14 – one form for each of us.

We also did the same thing earlier this month (March 2016) for tax year 2015.

The only other IRA transaction is a small RMD I have to take from an inherited non-spousal IRA which I have been doing for years.

We now, as of 29 January 2016, each have the 2015 Form 1099-R for conversion out of our traditional IRAs and the 2015 Form 5498 for contributing to our Roth IRAs.

Our questions are (using H&R Block Deluxe for our 2014 and 2015 returns):
1. Do we have to amend our 2014 tax return and, if so, how?
2. How do we report on our 2015 tax return, given we have done this for tax years 2014 and 2015?

If you read this article, the takeaway should be stop doing it that way. Catch up and make it planned for 2016. Your 2014 is fine. For 2015, follow the same guide in How To Report Backdoor Roth In H&R Block Software. Enter $6,500 in “Your Total Basis In Traditional IRAs”, which is the number on line 14 of your previous year’s 8606 form.

Trouble with entering my situation in turbo tax. I was attempting backdoor Roth, but accidentally directly invested in my existing Roth for $5500 on 2/2/15. I realized mistake and called vanguard to do recharterization on 2/5/16 to traditional IRA for $5500 plus $71 gain. On 2/6/15, the conversion to the Roth IRA was processed for $5508. With turbo tax I am having trouble how to enter? My form 8606 does not seem right? Should it only reflect the $5500 as if the recharacterization never happened? Do I have to record the gain somewhere or the extra $8 in the conversion? Appreciate your forum.

Assuming your 2/5/16 meant 2/5/15, just enter the events as you described. Assuming the original contribution was for 2015, start the contribution as Roth. When it asks you if you recharacterized, say yes. In the 1099-R section, enter the 1099-R for $5,571 recharacterization. Then enter the 1099-R for $5,508 conversion. The 8606 should show $8 taxable.

I was in a similar situation as bill and tried to fill out the steps you had described.

In early 2015 when I was filing my 2014 taxes, I realized a work bonus made me eligible only for a partial roth ira (did a regular roth ira for the full 5500 in 2014. I ended up re characterizing what amounted to be 1040 of roth ira to a traditional ira and converting it back to roth via the backdoor method and sent in a statement of explanation (I also did a full backdoor roth for my 2015 ira).

This year while filing my 2015 taxes I received my 1099-r. It has two rows under “contributory ira” one row is for the 5500 backdoor roth i did for the 2015 tax year and the other is for the 1040 that i re-characterized both with distribution code 02 for tax year 2014 (the roth conversion was done in 2015 for this amount).

It also had a third row under “Roth IRA” with the amount I had re-characterized from the roth of 1000 with distribution code r.

However my taxes owed then went up a few hundred dollars after entering the 1040 and 1000 amounts. This didn’t make much sense to me as the taxable amount after the re-characterization was only 40 dollars (basis was 1000 at the time of recharacterization the value went to 1040). Not sure what I am doing incorrectly?

You did it correctly. You just haven’t reached the IRA contribution part yet. After you enter your $5,500 contribution plus $1,000 carryover, the tax will come back down. Ignore the interim tax meter. It isn’t final until you go through all the parts.

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